Pharma space to report a healthy Q3; is the road ahead smooth?

The Indian pharma space is teeming with positivity with brokerages and analysts anticipating a healthy December quarter scorecard from the sector.

Along with IT, pharma emerged as the sector that gained the most in the wake of the coronavirus pandemic as investors turned towards pharma theme, betting on COVID treatment and the trend of India emerging as a major bulk drug supplier.

According to the global brokerage firm CLSA, this was the first time in five years that the Pharma index outperformed the Nifty.

The growth story of the Indian pharma space is likely to continue in the year 2021 also.

"The rising contribution from differentiated products in the US, a greater focus on higher-margin top brands in India and some sustenance of ongoing cost control measures should lead to an improved margin profile for India’s pharma companies and should form a key lever for earnings growth in 2021," CLSA said.

Earnings expectations

Brokerages are of the view that the Indian pharma companies may report a rise in their operating margins on improved product mixes and cost control along with normalisation in volume growth during the quarter ending December 2020.

The pharma space, especially the large players, is expected to report a healthy quarterly scorecard.

Brokerage firm Motilal Oswal Financial Services expects earnings for the healthcare universe to grow by 41 percent YoY in Q3 against 24 percent/33 percent in Q1/Q2FY21, while sales should increase by 11 percent.

"All companies in our coverage universe are expected to post a YoY profit growth, with 15 out of the 19 companies expected to post an over 20 percent PAT growth," Motilal said.

Kotak Institutional Equities expects the domestic formulations segment to report 3 percent to 6 percent year-on-year (YoY) growth on an underlying portfolio basis except for Cipla and Dr Reddy's.

Kotak expects 17 percent YoY growth for Cipla's domestic business despite moderation of Covid portfolio while Dr Reddy's full quarter consolidation of Wockhardt portfolio will drive higher growth on a reported basis.

Besides, Kotak expects US revenues to increase QoQ across companies with Lupin and Cipla benefitting from market share gains in albuterol, Dr Reddy's from a product launch and Sun witnessing a ramp-up in US specialty sales.

EBITDA margin may moderate QoQ for Sun, Cipla, Dr Reddy's and Torrent, driven by lower export incentives in the quarter and higher SG&A spend as marketing activities increase, Kotak said.

YES SECURITIES believes the Q3FY21 numbers of the pharma sector would build upon the recovery seen in the previous quarter.

"US performance would continue to be strong for Dr Reddy's Labs on back of few good approvals in Oct‐Nov while Lupin would benefit from Tamiflu and Albuterol opportunities. Sun's specialty portfolio would maintain growth on a low base even as we built in fuller recovery in Taro," YES SECURITIES said.

"Domestic business would chug along at 5‐6 percent run rate for larger players while select ones like Torrent would enjoy faster growth due to cardiac and vitamins heavy portfolio," said the brokerage.

The estimates of YES SECURITIES shows the US sales for Alkem, Ajanta to sustain at 15‐18 percent YoY on the back of approvals and a small base.

The road ahead

The Nifty Pharma index gained more than 60 percent in 2020 and more than 108 percent since March 2020 lows and ended in the green after 5 years of consolidation.

Some mid and small-cap pharma stocks turned out to be multibaggers in the last couple of years.

"The rally in the pharma space has been driven by a pick-up in the domestic and the export market along with some positive anti-China sentiments also. Some of the API manufacturing companies have surged more than 300-400 percent in a year. We expect API story to consolidate in FY2021 as growth in revenue and net profit will be in the range of 10-20 percent as compared to growth of 30-60 percent in FY20," said Yash Gupta Equity Research Associate, Angel Broking.

Gupta pointed out that the valuation gap between mid, small-cap pharma companies and large-cap pharma companies has come down significantly.

"We expect stock-specific momentum to continue in FY2021. We have a positive outlook on Cadila Healthcare and Lupin. We suggest investors be cautious on mid and small-cap pharma companies," Gupta said.

The rollout of COVID-19 vaccines in India will be another keenly watched space. Amongst the listed Indian companies, Aurobindo, Cadila Health and Dr Reddy’s are expected to play an important role in vaccine distribution in India, according to CLSA.